Question

Explain the relationship between interest rates and bond value. What makes interest rates change? Is it possible to lose money if you invest in bonds, even federal government bonds? Why or why not?

Answer 1

To speak about the relationship between rates and bond value is depicted byb following formula

Let us assume a bond paying coupon C annualy with face value of 100 and time to maturity of T and Yield to maturity of r then Market Value of Bond is calculated as

V=C/(1+r)+C/(1+r)^2+...+(100+C)/(1+r)^T

As Value of Bond decrases with increase in YTM and vice versa.

Interest rate are affected by many macroeconomic factors such as inflation and Country risk if we speak about federal bonds and company defalut risk if Corporate bonds are considered.

It is possible to lose money in bonds if governemnt is unable to repay the bond on maturity due to increase interest payment (Interest rates on government security may increase due to macroeconomic instability that is conutry risk)

Increase in rate decrease the value of government bond.